Facebook's Right Price Could Be $14; Watch Out for the Cliff

With tech stocks, the cliff comes hard and fast. Normally, professional investors hold a consensus view of a company and track the financial metrics to make sure the company is performing. If contrary indicators arise, Wall Street ignores them for awhile. But once the unexpected data points hit critical mass, then all of a sudden, the opinion reverses. That’s why the chart for Facebook is going to look asymmetrical.

What’s the right price for a company with slowing revenue growth, falling margins, saturated penetration, double counting of users and an unproven business model? Is it Facebook’s 45 times earnings and 20 times revenues? That seems rich for a start up.

On average, tech companies with good growth prospects and solid management sell at 15-20 times earnings and 3-4 times revenues. Facebook is twice as expensive, and its prospects may be the same.

This week, lawyers alleged security-laws violations for selective disclosure of material news, yet despite these broadside hits, the stock defies gravity. Facebook may benefit from underwriter support for awhile, but not forever. Once the reality of its financial outlook catches up, holders will flip and potential investors will stand down. When short sellers can borrow the stock, it will get pummeled, whether or not the courts find a 5% change to guidance was “material.”

Investors will become more conservative on Facebook’s outlook, adopting a show-me attitude. After Facebook’s very public IPO debacle turned up of whole host of surprises, investors are ready for a re-calibration. At $31 a share, Facebook is an outlier somewhere around Pluto.

Through the IPO, management’s inexperience was evident. CEO Mark Zuckerberg’s unilateral control of Facebook makes some veteran investors nervous. And, his last-minute adjustments to max-out the take while adjusting down forecasts makes him look like a novice, damaging credibility in the capital markets. “It is the Wall Street equivalent of holding up a 7-11,” said one holder.

Investors rarely benefit in a contest with a CEO with voting control, but with a proven manager, investors are willing to give some latitude. This CEO is not forthcoming. For example, he says he plans to facilitate “open and transparent communications,” but sells entrusted private data to advertisers.

With its growth tapering off, the intrinsic value of the stock could be lower than its trading price. There’s a big unknown about monetizing mobile, which could become the preferred Facebook access. PC users accessing via phone apps don’t get ads on their small screens. And, users who sign up for mobile accounts don’t get ads either. Ads are money. Mobile access may eclipse PC access, which means revenue growth will decline.

Zuckerberg bought mobile-software Instagram for $1 billion to expand mobile services, but the acquisition could be dilutive over the short run. The quick negotiation hints that the mobile encroachment is bigger than investors expect. And new products are an iterative process, so finding a winning template may take time.